Affected by the impact of the epidemic and the increase in costs related to the second phase of operation, the 2022/2022 H2 company's operating income fell 28.9%/27.1% year on year, and net profit loss was 16/14 million yuan. Of these, the annual AfAC revenue decreased by 28.2%, or mainly due to a 42.4% year-on-year decrease in duty-free sales. The increase in costs and expenses during the same period mainly came from the second phase of operation. The company leased an annualized rent of assets related to the parent company of 570 million yuan, which was better than market expectations and helped reduce the company's cost pressure during the period of increasing capacity utilization. Company traffic fell to a low point in 2022, and the contribution of the new terminal to production capacity, the opening of new duty-free areas at the end of 2021, and the boutiques invested in Q4 2022 did not have a good effect on driving sales. It is expected to be gradually realized in 2023. The company is expected to enjoy the outlying islands duty-free and free trade port development dividends, and the company's duty-free sales may exceed 11 billion yuan by 2025. We gave the company a target price of HK$25 for 2023, giving it a “buy” rating.

Affected by the impact of the epidemic and the operation of the second phase of the project, the company lost 160 million yuan in net profit in 2022. We expect that in 2023, driven by the year-on-year effect of new costs subsides, demand recovery gradually matches production capacity, and the growth of new duty-free areas, the level of profit is expected to increase significantly. Due to the impact of the epidemic, the number of visitors to the island declined markedly in 2022. The corresponding company's 2022 revenue fell 28.9% to 1.14 billion yuan year on year, and Guimo's net profit loss was 160 million yuan (vs. Fumo's net profit of 770 million yuan in 2021). Among them, 202H1's operating income fell 27.1% year on year to 5.2 billion yuan, and Guimo's net profit loss was 140 million yuan (vs. 2021H2 Guimo's net profit of 4.2 billion yuan).

The company's operating costs increased 28.8% year-on-year in 2022, mainly due to additional related operating expenses and depreciation and amortization after investing in the second phase of the project. The double pressure on the revenue and cost side caused the company's gross margin to fall by 28.8 pcts to 1.6% year on year, and the company's operating cash flow decreased by 79.0% to 170 million yuan during the same period. We expect the company's profit level to rise markedly as the year-on-year effect of the costs associated with the second phase of the 2023 project gradually subsides, demand recovery gradually matches production capacity, and the new duty-free area drives African aviation revenue.

In 2022, the company's duty-free sales fell 42% year on year, leading to a 28% decline in African aviation revenue. Since 2023, demand to the island has recovered rapidly. We expect passenger throughput in 2023 to increase or around 5% year on year compared to 2019. Affected by the COVID-19 pandemic, the company's passenger throughput/ aircraft take-off and landing times in 2022 was -36.3%/-27.0% compared to the same period in 2019, of which 202H2 was -60.7%/-47.3% compared to the same period in 2019, corresponding to -30.4% of annual aviation business revenue and -28.2% of non-aviation revenue, which is similar to the decline in business volume. Among them, franchise revenue fell 32.0% year on year to 450 million yuan, or offline sales of Meilan Airport outlying islands duty-free shops dropped sharply mainly due to reduced passenger throughput. We expect Haikou Meilan Airport duty-free shop offline sales to be about 2.2 billion yuan in 2022, a decrease of 42.4% over the previous year. Demand for island tours has recovered rapidly since 2023. Combined with the peak Spring Festival holiday season, the company's passenger throughput and aircraft take-off and landing times from January to February increased by 25.5%/6.1% year-on-year, recovering to 89.7%/97.0% in the same period in 2019. According to “Which Platform to Go to” data, since March this year, the number of inbound and outbound bookings in Haikou has increased 19% compared to the same period in 2019.

We expect that the company's business volume during the May 1st to summer travel season is expected to exceed the same period in 2019, and the annual passenger throughput may increase by about 5% compared to 2019.

The increase in cost mainly comes from the operation of the second phase of the project. The rent plan is better than market expectations, which helps the company increase its profit level during the period when capacity utilization is rising. In 2022, the company's operating costs/sales costs/management expenses were +28.8% /- 28.0% year-on-year, respectively. The total year-on-year increase was 21.8% to 1.21 billion yuan, an increase of 50.7 pcts higher than revenue (-28.9%). Among them, labor costs increased 12.0% year on year (45.1 million yuan), mainly due to the second phase expansion project being put into use and the increase in labor costs due to the increase in personnel; at the same time, depreciation and amortization of related assets increased due to the increase in depreciation and amortization of related assets due to the introduction of the second phase expansion project, which led to a 106.73% year-on-year increase (176 million yuan) in depreciation expenses for fixed assets and investment real estate. Financial expenses increased by 312.4% ($66.78 million) during the same period, mainly due to the second phase of the expansion project being put into use, the cessation of interest capitalization on related loans, and the Group's additional loans. We expect the current cost increase of about 400 million yuan to be brought about by the second phase of the project. In November 2022, the company announced a rent plan for leasing assets related to the parent company's phase I and phase II. The annualized rent was 560 million yuan, which was better than market expectations. It reflected the group's support for listed companies and helped the company reduce cost pressure and increase profit levels during the subsequent period of increased capacity utilization.

The company is expected to fully enjoy the outlying islands duty-free and free trade port development dividends. In 2025, duty-free sales may exceed 11 billion yuan. The National Immigration Administration will resume visa-free entry to Hainan Province from March 15. From April 11 to 15, the 3rd Consumer Fair will be held in Haikou City. Last week (3.28-3.24), the recovery rate of the company's flight volume rose to 102.1%. It is expected that, driven by the exhibition, the recovery rate in April will continue to rise. According to pre-flight, the company's average weekly flight volume for the 2023 summer/autumn season increased 7.5% compared to the 2019 summer/fall season, or mainly benefited from the increase in production capacity brought by T2. We expect the company to accept mainly additional passenger traffic to the islands before 2025, and will fully enjoy the outlying islands duty-free and free trade port development dividends. The company's traffic fell to a low point under the influence of the epidemic in 2022. The contribution of the new terminal to production capacity, the new duty-free area opened at the end of 2021, and the driving effect of the boutique stores invested in Q4 2022 were not well reflected. It is expected that it will gradually be realized in 2023, and the company's duty-free sales may exceed 11 billion yuan by 2025.

Risk factors: The recovery in civil aviation demand was weaker than expected; the increase in duty-free revenue at Meilan Airport fell short of expectations; the Group's runway injection, fixed increase implementation and arbitration results fell short of expectations.

Investment advice: Affected by the impact of the epidemic and the increase in costs related to the second phase of operation, the company's operating income fell 28.9% year on year and net profit loss was 160 million yuan in 2022. Among them, non-aviation revenue decreased by 28.2%, mainly due to a 42.4% year-on-year decrease in duty-free sales. The increase in costs and expenses during the same period mainly came from the second phase of operation. The rent of assets related to the company leased the parent company was better than market expectations, which helped reduce the company's cost pressure during the period of increasing capacity utilization. The company's passenger traffic fell to a low point in 2022, and the contribution of the new terminal to production capacity, the opening of new duty-free areas at the end of 2021, and the boutiques invested in Q4 2022 did not have a good effect on driving sales. We expect it to be gradually realized in 2023. The company is expected to enjoy the outlying islands duty-free and free trade port development dividends. We expect the company's duty-free sales to exceed 11 billion yuan by 2025. Based on the company's 2022 performance report, we adjusted the company's 2023/24/25 EPS forecast to $1.09/1.96/2.71 (the original 2023/24 EPS forecast was $1.53/1.96, and the 2025 EPS forecast was a new increase). Referring to Beijing Capital Airport shares, which is also a Hong Kong-listed company, the average PE (ttm) value for the 3 years before the pandemic was 15 times. Considering the rapid growth of the company's duty-free business, we gave the company a PE valuation of 20 times in 2023, corresponding to the target price in 2023 HK$25, maintaining the “buy” rating.